The China factor

What a strange day in the markets. It certainly began badly: higher than expected wholesale inflation and lower than expected industrial production figures for April (as to these, weakness was concentrated in the automobile sector). Yet, in the end the broad indices managed to rise nearly 1%.

Most commentators stated that a Treasury Department report to Congress on exchange rates and trade saved the day. This report warned China that unless it takes steps soon to make its exchange rate more “flexible” (that is, let it rise), it would be branded as a “currency manipulator”, a designation that would give free rein to the Congressional demons of protectionism

So why is this good news? Well, the dopiest reporters argued that American stocks rose because these warnings would be heeded and American firms will eventually face less Chinese competition. Smarter hacks said that the positive reaction reflected a collective sigh of relief, since apparently some talking heads had expected the Treasury to accuse the Chinese of manipulation in this report.

I know, it doesn’t make much sense either. My guess is that stocks rose in sympathy with good earnings numbers from H P and Home Depot, among others.

As to the China factor, some experts argue that letting the yuan rise would be a good idea, since it’d be a necessary step for correcting the current unbalanced state of the world economy (Brad Setser is in this camp, broadly speaking). Other fear it will plunge China –and probably other East Asian economies--into a nasty Japanese-style deflationary spiral, with negative consequences for the world economy (Andy Xie of Morgan Stanley more or less supports this view).

In other words, no one really knows, but everyone agrees it will have a big impact. Oh, and by the way, is it really a good idea to push around the face-saving, prickly, Chinese who happen to finance a rather large chunk of government spending in the U.S.?